Nov 28, 2008

World - Crisis hits Romania at poll time

Vlad Georgescu

Not too long ago it was riding the wave of Eastern Europe's economic boom. With 8% annual growth, Romania - one of the newest members of the European Union - was the envy of Old Europe, seemingly impervious to the global economic decline.

But the aura of invincibility has started to fade before a crucial round of parliamentary elections on Sunday.

In recent weeks, Fitch and Standard and Poor's credit agencies cut Romania's rating to "junk", worried by its large current account deficit and reliance on short-term borrowing.

Hit by the global financial crisis, foreign investment has slowed and the local currency has fallen against the euro.

The young millionaires of the property market shivered when prices took a dive to levels never seen in the past decade.

Political twist

Just as the credit rating agencies realised something was wrong in the state of Dracula, politicians have realised that talking about "bust" rather than "boom" could give them the edge in elections.

Politicians have jumped on the bandwagon of populist promises.

The Social Democratic Party has bounced back in opinion polls in the past week after its leader started to talk about redistribution of wealth and the need for Romanians "to tighten their belts".

The pro-Western Democratic Liberal Party, formerly part of the government coalition, is struggling to adjust its message to respond to an electorate which feels Romania is no longer insulated from the worldwide turmoil.

Large deficits

The credit agencies' decision to cut the rating came after the government initially caved in to unions' pressure to raise teachers' salaries by 50%, putting the country's finances at risk.

Romania's central bank sits comfortably on a 27bn euro reserve but its large current account deficit and reliance on short-term borrowing makes it vulnerable at times of crisis, said David Riley, head of Fitch's global sovereign ratings group.

Romania's deficit is expected to exceed 14% of GDP (Gross Domestic Product) this year and, for David Riley, such figures clearly suggest that external financial support will be needed.

Feeling the pinch

Romania is now the only country in the European Union with a junk rating on its bonds, which is bad news for the Romanian government, given that investors are more conscious than ever of ratings downgrades.

A country which attracted 7.2 bn euros (£5.8bn) worth of investment in 2007, appears to have lost its appeal to investors.

Once enthusiastic about Eastern Europe, investors have dumped assets amid concerns that other countries with large debt deficits could follow Hungary into crisis.

The downgrade also hit the local currency, the Romanian leu, which fell against the euro.

Foreign investors, who made serious money in Romania in the last decade, are now suffering.

French car maker Renault temporarily closed its Romanian plant, Dacia, as demand for its cheap compact model, Logan, started to dwindle worldwide.

But hardest hit is the once-booming property market. With prices in old communist blocks of flats falling 30% year-on-year and new developments also hit by from falling demand, some foreign investment funds have to quit the country overnight.

"They tried to sell, but the prices they were offered were so low, that they had to stay," says Ioan Radu Zilisteanu, the Romanian Association of Estate Agents' spokesman, who says that investments in the local property market fell 50-60% in 2008.

In denial

So far the Romanian government have maintained that they have enough resources to weather the storm by themselves - without seeking help from the international community - but some analysts wonder if the country is blinded by its own success.

After six years of economic boom, with salaries rising by an average 15% a year, many Romanians have difficulties grasping the impact of a truly global economic recession.

The government is under pressure not only to raise the teachers' salaries, but also to raise the minimum wage and improve social benefits.

"I am sure that many populist policies they are talking about now will never see the light of day when the new government is up and running. They are simply impossible to apply," says Radu Craciun, the chief investment officer at the US pension fund Interamerican.

Time to choose

Whoever wins the next election will face a challenging task - to keep the economy growing in 2009, despite the global downturn.

"The reality is that, next year, Romania will have difficulties in financing the ballooning deficit. In the current climate the direct investments will fall and some of the past debts will have to be repaid. Private companies will also have problems when raising money overseas," says Interamerican's Radu Craciun, adding that the authorities will have to tread carefully if they want to protect what Romania has achieved so far.

"We will have an adjustment. Things cannot continue as they are and next year we will see, for the first time in many years, an increase in the unemployment rate," he said.

There is still time for Romania to engineer a soft landing for its economy.

"The question is whether Romania manages to adjust its pace of growth through a soft-landing, by controlling spending, or it will take a massive hit on its currency," he said.